Some misconceptions about Iraqi supplies

Dec 12, 2002 01:00 AM

Oil figures large in the debate over the current crisis with Iraq. How could it not? Yet, when it comes to oil, there
are two decidedly different points of view. According to some, the Iraq crisis has been created as a pretext and
cover for an “oil grab” by the United States, Britain and the international oil industry.
According to others, Iraq, once liberated from the current regime, will flood the world market with cheap oil,
boosting economies and providing a quick fix for concerns about our energy security. Although there is a wide gulf
between them, both these points of view have one thing in common -- basic misapprehension about the scale of
Iraq’s oil industry and the timing for new production.

No question, Iraq is a very big oil country. Its reserves are the second largest in the world -- behind only those of
Saudi Arabia. But when you look at Iraq in terms of its production capacity, the picture is different. It represents
just 3 % of the world’s total. Its oil exports are at about the same level as Nigeria’s.
Physically, Iraq could double its current capacity. But that could well take a decade or more. In the meantime,
growth in production elsewhere would limit Iraq’s eventual share of world production capacity to perhaps 5 % --
still significant, but still also in the second tier of oil nations. Yet even that kind of outlook assumes that Iraq
will welcome foreign investors on a reasonable timetable.

History warns that such is not a foregone conclusion. After the 1991 Gulf War, a liberated and grateful Kuwait
announced that it would open its oil industry to foreign investment in order to boost production. Eleven years later
that has yet to happen -- because of nationalistic opposition in Kuwait’s parliament.
In contrast to the 1990-91 Gulf crisis, which was more about energy security, this current crisis is focused on
overall security -- Iraq’s weapons of mass destruction and what to do about them. But, with that said, there is
a clear energy dimension to the confrontation: the security and stability of the Gulf region, from which flows almost
a quarter of the world’s oil.
Saddam Hussein’s drive to dominate the region is obvious. He invaded Iran in 1980 and then, a decade later,
invaded Kuwait and threatened Saudi Arabia. The other Gulf states have no love for him and much fear -- and both with
good reason.

But it requires several leaps of logic -- as well as inattention to developments in the rest of the world, notably in
Russia, the Caspian region and West Africa -- to conclude that the current Iraq crisis is “all about
oil”. No US administration nor any British government would launch so momentous a campaign -- and take such
risks -- just to facilitate a handful of oil development contracts and a moderate increase in supply half a decade
from now.
What would be the future of Iraqi oil without a Saddam Hussein? The discussion now under way -- which takes place
under the rubric of “the day after” -- is much more dominated by the uncertainties and risks than by the
benefits. The most immediate question involves a possible war and the damage that might result for Iraq’s
output at the very moment when a new regime would desperately need oil revenues to secure its own stability.

There is also much apprehension that Saddam would torch Iraq’s oil facilities in a Pyrrhic defeat. After all,
that is exactly what Iraqi forces did on their way out of Kuwait in 1991. It took eight months to extinguish the
fires in the Kuwaiti oilfields. This time, however, the prospect of post-war tribunals in Iraq might deter some Iraqi
commanders from obeying any such orders.
With the “day after” comes the critical question of authority. Who would be making decisions? Who would
be in charge? If there is a temporary military government, it would be preoccupied with establishing firm control
over Iraq’s weaponry and laying the basis as quickly as possible for a new Iraqi government with broad
representation. Security would certainly be an immediate and central focus, including the security of the oil
facilities.

After all, the country earns the bulk of its living -- $ 15 bn (£ 9.5 bn) in 2001 -- by exporting oil. For that
reason, any temporary military authority would be keen to see the “new” Iraq maximise its oil earnings.
But a military authority would be loath to get much involved in the decision making about the future of the industry.
Rather, it would try to push the responsibility into the hands of a new Iraqi government -- or an interim group of
technocrats.
For its part, any new Iraqi government will be intent on getting its arms around its number one economic resource so
that it can generate as much revenue for reconstruction and development as quickly as possible. Iraq is not
Afghanistan. It has the means, through oil, to pay for rebuilding the country.
But a new government will also have another priority. It will be determined to bolster its sovereignty, legitimacy
and nationalist credentials -- all of which will be essential requirements for holding the country together. This
ensures that when the time comes to sit down with the oil companies, Iraq will be a tough negotiator.

One of the reasons that the “It’s all about oil” discussion gets off on the wrong track is that it
makes the assumption, often without realising it, that Iraq would turn over its current 2.8 mm bpd of production
capacity to international companies. In this view, that is the new “prize” that is supposedly up for
grabs. But that’s a misleading assumption.
Why would a new Iraqi government want to do that? If it brings in foreign companies, it will have to split revenue --
keeping perhaps 88 cents of every $ 1 of earnings for itself, but with 12 cents or so going to the companies.
Yet the new Iraq does not need the international companies’ investment for fields that are already developed.
It’s much more sensible for Iraq to keep the whole dollar for itself and simply purchase what it needs in terms
of technology and equipment for the existing fields.

However, for its undeveloped fields, a post-Saddam government will need capital -- lots of it -- for exploration and
new production. And that is when a new regime is likely to turn to international oil companies. Which ones? It will
have no shortage of suitors.
Once things are clear, companies will be eager to get in line to sign contracts with a country that has 11 % of the
world’s proven reserves. (Saudi Arabia, the highest, has 25 %; the North Sea has just 1.7 %.) But they will be
cautious when it comes to spending billions of dollars until they are pretty confident about security and stability.
And, for the companies, “stability” applies both to the new regime itself and also to the contracts they
sign with it.

Companies from several countries -- Russia, France, Italy and China, among others -- already hold contracts, but they
are not operational because of UN sanctions still in place. Companies without contracts, including the British and
American ones, will have to assess how much time and trouble they are willing to bear. For the oilcompanies, the big
issue, wherever they operate in the world, is how to manage the range of risks -- from the geological to the fiscal
to the political. In response, they often work together in consortiums and partnerships. This approach enables them
to hedge their bets, spreads their investments and diversifies their portfolios.
That’s likely to be the way things work out in Iraq. The companies with existing contracts will likely team up
with other companies -- American, British, European, Canadian, Australian, Japanese -- to form new partnerships. Such
partnerships would also meet the crucial need of a new Iraqi government, which would want to strengthen its position
by dealing with a diversified political portfolio of companies representing many different nationalities.

A lot has to happen and none of this will take place swiftly. It might take a new regime a year or so just to get
things organised and begin to negotiate contracts. When it does, it will have to face the stark reality -- the
deteriorating condition of the Iraqi oil industry.
Production capacity has dropped from its peak of 3.5 mm bpd in 1980, before the Iran-Iraq War, to about 2.8 mm bpd.
It continues to fall. Reservoirs have been damaged by years of mismanagement. The infrastructure -- whether wells,
pipelines, pumping stations or ports -- is in poor shape. Equipment is rusting and malfunctioning. Environmental
considerations are widely ignored. To get back to 3.5 mm bpd could take three years or more, at an estimated cost of
at least $ 7 bn.
This would put Iraq back into the leagues of Norway, Iran, the United Arab Emirates, Mexico and Venezuela. The next
hurdle is to increase production above that.

Another 2 mm bpd would require a major push and would still leave Iraq several rungs below the capacity of the big
three producers -- Saudi Arabia, the United States and Russia. Unless almost everything worked almost perfectly,
making that leap to 5.5 mm bpd would come some time after 2010 -- at a cost of upwards of $ 20 bn.
As its output increased, Iraq would begin jostling its Gulf neighbours for market share. Some assume that this would
turn Iraq into an OPEC-buster. But its likely growth in output would not give Iraq that kind of clout. It would not
have the ability to “flood” the market. Nor would it have the desire. Its intense need for revenues would
make it much more interested in selling oil at $ 20 or $ 25 a barrel, rather than at a bargain basement rate such as
$ 10.

By 2010 world oil demand, driven by countries such as China and India, could be almost 90 mm bpd. That would be 17 %
greater than today. Where will that oil come from? Here’s where the picture grows more complex.
The outlines of a larger competition are already starting to become clear. On one side are Russia and the Caspian
countries, primarily Kazakhstan and Azerbaijan. Standing on the other side is the Middle East, including Iraq. Over
the past three years, spurred by what has been called “the miracle in the Russian oilfields”, Russian
output has increased by almost 25 % to 8 mm bpd. The race heated up with the recent announcement by four Russian oil
companies of their intention to build a new Arctic port to export directly to the United States.

Right now, Russia and the Caspian nations seem to have the edge in this race. They look likely to score the bigger
gain. All that, however, is subject to change. The outcome will be determined not only by geology and the balancing
of opportunity and risk by companies, but also by political and economic stability and the decisions governments
make.
But this larger race to supply growing world demand has a clear and tangible prize: By 2010 the growth in world oil
consumption could mean an additional $ 100 bn or more a year in oil revenues flowing into the treasuries of nation
states. After “the day after”, Iraq will be better positioned -- and highly motivated -- to compete for
its share. It will be a strong competitor. But it will also be only one of several strong contestants.

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